BFP Management Blog

Investors are buying houses to rent and/or to flip which is an excellent sign that we may be at or near a bottom in a number of markets. Certainly on the low end, cash on cash returns from rental income are coming in at 8%+ (into the double digits). These vulture investors are picking the meat off of the bones which is good both in nature and in economics.

To get the best deals, buyers are purchasing using all cash. In fact, January was a record in California as 30.9% of all transactions did not involve any financing. Not surprisingly, the Inland Empire (Riverside and San Bernardino) recorded higher percentages.

Figure 1

The combination of stricter lending guidelines along with banks offloading properties through foreclosure or short sales were responsible for the upswing. The biggest reason though is that prices have continued to fall and the multiple of price to rent (Gross Rent Multiplier) has gotten into the range that makes financial sense to investors.

In figure 2, we see that existing home sales have picked up by about 25% in the last few months. While the amount of inventory currently on bank balance sheets and foreclosures still to come remains unclear, investors are voting with their wallets that prices make sense now. It should be noted that in the hardest hit markets of Miami and Las Vegas, over 50% of sales were distressed last month.

Figure 2

Given the very low rates of return that one gets from depositing money in the bank and a genuine concern about inflation, trading dollars for a tangible asset at far below replacement cost while getting high single digit or double digit yield has become attractive. I think it makes sense, even though I haven’t jumped in yet but I may buy some houses later this year.

The downside of the investor owned homes is for the apartment owners. The houses become “shadow inventory” of rentals that compete very well against multi-family properties. Not surprisingly, commercial mortgage-backed securities (CMBS) delinquencies are rising as seen in figure 3.

Figure 3

The worst performing of the CMBS loans in February were apartments at 16.61% being delinquent. This is an amazingly high percentage and for scale, approximately $170 billion of these commercial loans will come due over the next three years.

Recently I’ve been looking to acquire delinquent apartment loans in a “loan to own” strategy whereby I hope to purchase the underlying asset by buying the mortgage at a discount to the value of the property. While there are certainly risks in pursuing this course, one of the most difficult is to avoid catching a falling knife since I believe apartment operations and values may well continue suffering over the next few years. In other words, I am trying to predict where values (prices, rents and occupancy) are heading while my vulture counterparts are converting foreclosed houses into competition.

Clearly to acquire the best deals, “cash is king” and at least right now, houses by in large make better sense than do apartments.